The first metric is net amortization, which measures whether total contributions to a public retirement system are sufficient to reduce unfunded liabilities if all actuarial assumptions—primarily investment expectations— are met for that year. Plans with positive net amortization are expected to retire pension debt over time and therefore improve their funded status.
Pew reviewed the three-year average for net amortization. This figure provides a more complete picture of contribution adequacy given the impact of volatile investment performance and demographic experience on plan assets. In total, the 33 cities in Pew’s analysis achieved positive amortization (104% of the benchmark) from 2015 to 2017. However, individually, more than half of the cities had negative amortization. Notably, Chicago and Dallas contributed less than 50% of the benchmark. In contrast, New Orleans contributed 174%, or $132 million, which was well over the city’s benchmark over the time period. For cities that are poorly funded, net amortization can indicate that they are on a path toward sustainably funding their pension plans. For example, New Orleans and Philadelphia have both increased their contributions significantly in recent years to achieve positive net amortization and decrease unfunded liabilities. On the other hand, better funded cities that fell short of the benchmark may face growing pension debt absent a policy change or adjustment.
In a white paper for The Pew Charitable Trusts, Eric Scorsone and Natalie Pruett of the Michigan State University Extension’s Michigan Center for Local Government Finance & Policy assessed local government early warning systems through case studies in Colorado, Louisiana, Ohio, and Pennsylvania. Each of these states applies various financial ratios—an approach known as ratio analysis—and other indicators to identify signs of local fiscal distress. Ratio analysis uses fractions that capture financial or economic activity within a locality—such as total expenditures over total revenues—to measure solvency, the ability to pay debts and liabilities over the short or long term. Ultimately, the authors determined that there isn’t one optimal system and instead offer several recommendations for states to build or improve their early warning systems.
The authors present detailed descriptions of the four states’ systems and analyze trade-offs and implications of the indicators employed to measure different types of solvency. They offer a variety of recommendations for states to consider, including use of indicators for four types of solvency:
Overall, the typical pension fund is now expected to return approximately 6% annually over the next 20 years, compared with 6.4% pre-pandemic (Figure 4). This change in outlook is consistent with the reduction in the median long-term return found by a recent survey of pension investment consultants13 and aligns with revisions for public pension return expectations published by S&P Global.14
As states respond to the Covid-19 pandemic, many also face severe revenue shortfalls because of the economic downturn. These gaps between resources and planned spending pose immediate challenges for policymakers, who must balance budgets while addressing increased demand for public health and other essential services. Some states have already tried to cut costs by reducing or delaying contributions to public pension plans, and others may consider doing so if federal aid to states does not materialize.
The pandemic’s effect on state budgets has been significant. Fiscal year 2020 marked the first time that state general fund revenues declined since the Great Recession, with preliminary projections issued since March showing that states expected fiscal 2021 revenues to fall below initial estimates by about 10%, on average. More recent estimates indicate that state revenue shortfalls could total more than $300 billion cumulatively over fiscal years 2020-22.